CONTANT Pages What is demand --------------------------- 1 Elasticity of demand --------------------- 1 Price elasticity of demand --------------- 2 Quantity demand -------------------------- 3 Method of price elasticity ---------------- 5 Cross elasticity of demand ---------------- 12Income elasticity of demand --------------- 17Measuring of income elasticity -------------- 19
DEMAND The demand for a commodity is its quantitywhich consumers are able and willing to buy at various prices during a given period of time. ELASTICITY OF DEMANDElasticity of demand refer to price elasticity of demand, though the notion of elasticity of demand also relates to income, cross and substitution elasticity of demand.
PRICE ELASTICITY OF DEMAND The elasticity of demand is the degree ofresponsiveness of demand to change in price. In the word of prof. lipsey “elasticity of demand may be defined as the ratio of the percentage change in demand to the percentage change in price” thus price elasticity of demand is the ratio of % change in amount demand to a % change in price.Ep = %change in amount demand % change in price Represent into equation = change; q = amount of demand p = for price Ep= q/p
QUANTITY DEMANDCASE 1: when the change indemand is more thanproportionate to the change inprice. Price elasticity of demandis greater than unity orrelatively elastic Ep >1CASE 2: when the change indemand is less thanproportionate to change inprice. Price elasticity of demandis less than unity or relativelyinelastic Ep<1CASE 3: when the changes indemand is exactly proportionate tothe price Ep=1 unit
CASE 4: when whatever thechange in price there isabsolutely no change in demand.So price is perfectly inelastic inthis case Ep=0CASE 5: when an infinitesimalsmall change in price leads to aninfinitely large change in theamount of demand, so the priceelasticity of demand is infinity.Ep= ∞
Methods of measuring price elasticity The percentage method: - the price elasticity of demand is measuring by its coefficient (Eq). Thiscoefficient (Ep) measure the percentage change inquantity of a commodity demanded resulting from a given percentage change in its price. = change; Ep= price of elasticity Ep= %change in q/% change in p q = quantity demand; p = price if Ep>1= price is increase than demand then demand so demand is elastic. Ep<= price is smaller/decrease then demand, so demand is inelastic.Conclusion: - (1) when the quantity rise demand is elastic. (2) When the price rise the demand is inelastic.
The point method: - professor Marshall devised ageometrical method for measuring elasticity at a point on the demand. =change into quantity = change into price P, q = initial price q = BD=Q; p =PQ p = PB; q = OB
Substituting these values into the formula- Eq= QM PB PQ OB Moreover, QM BS PQ OB BS PB PB OB = BS/OB Since PBS and ORS are similar N= CN (lower segment) ND (upper segment) Elasticity of demand at points- M= CM = 5 =5 or >1 MD 1 (greater than unity)
L= CL = 6 ∞ CD 0 (infinity) p= CP = 1 or <1 PD 5 (less than unity)Conclusion: midpoint of the demand curve is the elasticity of demand is unity. THE ARC METHOD – we have studied themeasurement of elasticity at a point on a demand curve. It is known as ARC elasticity
point Price Quantity P 8 10 M 10 12 From P to M Ep = q p = (12-10) = 2 8 = 4 P q (6-8) -2 10 5If we move in reverse direction from M to P
THE TOTAL OUTLAY METHOD: Marshallevolved the total outlay or total revenue or total expenditure method as a measure of elasticity Total outlay =price quantityPrice /kg Quantity in TE in rs Ep 1 kgs 2 (1 *2)=3 4 9 20 180 8 30 240 >1 7 40 280 6 50 300 5 60 300 =1 4 75 300 3 80 240 2 90 180 <1 1 100 100
1. ELASTIC DEMAND: - demand is elastic when with the fall in price the total expenditure increases and with the rise in price the total expenditure decrease when the price falls from rs. 9 to rs. 8, the total expenditure increase from rs. 180 to rs. 240 and when price rise from rs. 7 to rs. 8 the total expenditure falls from rs. 280 to rs. 240 so (Ep>1) demand id elastic. 2. UNITY ELASTIC DEMAND: - when with the falls or rise in the price the total expenditure remains unchanged, the elasticity of demand is unity this is shown in the table when with the fall in price from rs. 6 to rs. 5 or with the rise in price from rs. 4 to rs. 5 the total expenditure remains unchanged at rs. 300 i.e. Ep=1
3. Less elastic demand: - demand is less elastic if with the fall in price, the total expenditure falls & with the rise in price the total expenditure rises. When the price falls from rs.3 to rs.2, total expenditure falls from rs.240 to rs.180 this is the case if inelastic or less elastic demand. CROSS ELASTICITY OF DEMAND The cross elasticity of demand is the relation between percentage change in the quantitydemanded of a good to the percentage change in the price of a related good. The cross elasticity of demand between goods A and B is Eba= %change in the quantity of B %change in the price of AIt can also be measured with the formula of ARC elasticity with the difference that here price and quantity refer to different goods.
(A) Cross elasticity of substitutes:- in the case of substitutes the cross elasticity is positive and large. The higher the Eba, the better substitutes the goods are. If the price of butter rises, it will lead to increase in the demand for jam.CASE 1 Eba>1 if a change in the price of good A leads to more than proportionate change in the demand forgood B, the cross elasticity is high. CASE2 Eba=1 when achange in the price of good Acauses the same proportionate of good B so the crosselasticity of demand is unity.
CASE3 Eba<1 when the quantity demanded of good B change less thanproportionately in response to thechange in the price of good A, asin panel (c) it means that good A and B are poor substitutes for each other. CASE4 Eba=0 when the change in the price of good A has noeffect what so ever on the demand for good B the cross elasticity of demand is zero. CASE5 Eba=∞ In case the two goods are perfect substitutes the cross elasticity of demand will be infinity.
Cross elasticity of complementary goods- if twogoods are complementary, a rise in the price of oneleads to a fall in the demand for the other. Rise in the price of cars will bring a fall in their demand together with the demand for petrol. Similarly, afall in the prices of cars will raise the demand for petrol.Case-1 if the change in quantitydemanded B is exactly in thesame proportionate as the changein the price A, the cross elasticityis unity (Eba=1) Case2-when the change in thequantity of B is less in response to a change in the price of A, so the cross elasticity is less than unity (Eba<1)
Case3-in the case of complementary goods, crosselasticity is greater than unity (Eba>1) when the change inthe demand for B good is more than proportionate to the change in the price of good.Case4- when the change in the price of A causes no changewhat so eves in the purchases of B so the cross elasticity of demand is zero (Eba=0) case5-when an infinitesimalchange in the price of A causes an infinitely large change in the purchase of B, so it is infinity (Eba=∞)
INCOME ELASTICITY OF DEMAND Ey= %change in quantity demand % change in income Demand=Q Income=Y Case-1 Ey>1 (in the case ofluxury goods) when the quantity is more than income Ey?>1 and this shows positive and elastic income demand. Case-2 Ey<1(in the case of necessary goods) when theincome rise more than quantity when Ey<1 and this showsnegative and inelastic demand.
Case-3 Ey=1(in the case ofcomfort goods) when the quantityand income increase or decrease in same proportionate so the relationship between income and quantity is Ey=1. Case-4 Ey=∞ when the incomeincrease is less proportionate then quantity so Ey=∞.Case-5 Ey=0 when the quantity isconstant and the income increase continuously so the relationbetween the income and quantity so Ey=0
MEASURING INCOME ELASTICITY OF DEMAND Relationship – income and quantity Ey=DQ Y = QA = LQ >1 DY Q OQ QA 1. Ey>1 luxury 2. Ey<1 necessary 3. Ey=1 comfort Ey = DQ Y DY Q
(1) In figure where LA is tangent to the Engel curve E, at point A. the coefficient of income elasticity of demand at point A is Ey= DQ Y = LQ QA = LQ >1 Dy Q QA OQ QAThis shows that the curve E is income elastic over much of its range. When the Engel curve is positively sloped and Ey>1 it is the case of a luxury good. (2) In figure where NB is the tangent to the Engel curve E2 curve over much its range is
larger than zero but smaller than 1 when the Engel curve is positively sloped and Ey<1 the commodity is a necessity and is income inelastic. In figure the Engel curve E3 is backwardsloping range draw a tangent GC at point C.the coefficient of income elasticity at point C is Ey= -GQ GC = -GQ <0 GC OQ QA This shows that over the range from B upward the Engel curve E3 is an inferior good.